Sustainable poverty

I actually wrote this some time ago, but I'm still seeing congratulatory notices about the award of the Nobel Peace Prize to a banker, Mohammad Yunus and his Grameen Bank. What most of these notices are suggesting is that, while criticisms can be made, the development of Grameen-type microfinance schemes has really achieved something towards poverty reduction.

Much of the criticism of the Grameen Bank and its numerous clones has been of the high interest rates charged. I don't actually have a problem with these rates. Sure, the rates are above those available from the rest of the banking system. But the trouble is that lower rates are simply not available to the poor. While the poor have a very high demand for credit, they normally have to resort to even higher interest rates from informal sector money lenders. From the banks' point of view, the poor are not creditworthy since they have no collateral to offer, their loans are too small and require too much administration (no economies of scale), etc. The risks of default are high. From the money lenders' point of view, they are creditworthy in so far as they can be induced to accept permanent indebtedness. For example, as long as they keep paying interest, they may not be required to repay the principal - the equivalent of endlessly renewing the loan. If they cannot pay the interest in money, there are ways to extract it in kind - a common example being the provision of labour. In some countries you can find people repaying the debts of their grandparents.

What Yunus has achieved is to demonstrate to the bankers that people without physical collateral can be rendered more creditworthy through the mechanism of 'social capital'. To be eligible for microfinance you have to be part of a group that guarantees your loan repayments. If one person defaults, the group has to cover the debt - so the majority of microfinance programs also try to encourage the groups to save. However, the savings schemes are less than successful, for the simple reason that poor people generally aren't able to save money. What happens is that many borrowers, in order to meet their repayments to the Grameen and other banks, have to borrow from the informal sector - either from moneylenders, in which case the payments required are regular and probably higher than those from the bank, or from family and friends, where they are likely to be less regular and can often be delayed.

Thus Yunus' great discovery was to find a way to transfer some of the income stream from money lenders to the formal banking sector and, to a lesser extent, to the poor.

Whether this actually has any impact on poverty reduction is another question altogether. For those who have to resort to moneylenders and others to meet their debt service requirements to the Bank, the answer is clearly no. For others, the answer is still moot. Loans available through microfinance schemes are very tiny (typically in the range $50-$200). This might be enough to establish a micro-enterprise, but it is scarcely going to enable somebody to accumulate sufficient capital to climb out of poverty. Successful micro-entrepreneurs might enter the realm of sustainable poverty, meaning the kind of poverty that is not going to kill them as early as it would otherwise have done. The risks remain very high: if your chickens die, or you suffer a bout of illness, you can still lose everything. Generally speaking, you're probably better off if you can find a factory job since regular wage income is generally higher than incomes from micro-enterprises. Regular wage jobs are in short supply, however, so Yunus' scheme of providing financial intermediation at lower rates than the money lenders is probably better than nothing. What it is not, is economic development.

Moreover, microfinance schemes are not themselves independently sustainable. The low default rates are a reflection of the continued dependence of the customers on the informal sector. The much vaunted 'social capital' of the borrowers is in fact simply a method of imposing discipline on them - forcing them to repay even when they cannot. Otherwise, microfinance has to be sustained by the subsidies from the commercial banking system - which is only possible when the banks are directed by the government. In Vietnam, for example, the Social Policy Bank (formerly known as the Bank for the Poor) is able to charge low rates of interest because its capital is supplied directly by the Agriculture Bank and others. The same applies to the large microfinance scheme operated by the Vietnam Women's Union which also obtains its capital from the Agriculture Bank. This system generates problems of sustainability for the banking system as a whole.

The problem of sustainability of microfinance has often been referred to in the literature, not only in the Vietnamese case. There have been many attempts to clone the Grameen Bank, but many, if not most, of them are unsustainable because they rely on subsidies to survive, basically because they do not generate savings deposits and, despite the high interest rates, their lending margins are insufficient to generate increases in loanable funds.